Exam 5: Gross Income: Exclusions

Juan, was considering purchasing an interest in a tax-exempt bond fund for $100,000, when he discovered that the interest must be included on his state income tax return. The interest rate is 5%. His marginal Federal tax rate is 35%, and his marginal state income tax rate is 10%. Juan itemizes his deductions on his Federal income tax return. As an alternative, Juan can purchase a state bond (a "double-exempt bond") yielding 4.9% interest that is exempt from both Federal and state income tax. Which investment would yield the greater after-tax return?

The exclusion of interest on educational savings bonds:

Hazel, a solvent individual but a recovering alcoholic, embezzled $6,000 from her employer. In the same year that she embezzled the funds, her employer discovered the theft. Her employer did not fire her and told her she did not have to repay the $6,000 if she would attend Alcoholics Anonymous. Hazel met the conditions and her employer canceled the debt.

Sandy is married, files a joint return, and expects to be in the 28% marginal tax bracket for the foreseeable future. All of his income is from salary and all of it is used to maintain the household. He has a paid-up life insurance policy with a cash surrender value of $100,000. He paid $60,000 of premiums on the policy. His gain from cashing in the life insurance policy would be ordinary income. If he retains the policy, the insurance company will pay him $3,000 (3%) interest each year. Sandy thinks he can earn a higher return if he cashes in the policy and invests the proceeds. a.What before-tax rate of return would Sandy be required to earn on the proceeds from cashing in the policy to equal the return earned with the insurance company? b.Assume Sandy estimates he can earn a 6% before-tax rate of return on the proceeds from cashing in the policy. Assume he can earn a 6% return for the remainder of his life and that he will reinvest all earnings at the same 6% before-tax rate of return. If Sandy expects to live 10 more years, which alternative will yield the greater amount to his beneficiaries upon Sandy's death? (Given: The future value of an annuity in 10 years assuming a 4.32% after-tax return is 12.19. The future value of an annuity in 10 years assuming a 2.16% return is 11.03).

Jena is a full-time undergraduate student at State University and is claimed by her parents as a dependent. Her only source of income is a $10,000 athletic scholarship ($1,000 for books, $5,500 tuition, $500 student activity fee, and $3,000 room and board). Jena's gross income for the year is:

Ben was diagnosed with a terminal illness. His physician estimated that Ben would live no more than 18 months. After he received the doctor's diagnosis, Ben cashed in his life insurance policy and used the proceeds to take a trip to see relatives and friends before he died. Ben had paid $12,000 in premiums on the policy, and he collected $50,000, the cash surrender value of the policy. Henry enjoys excellent health, but he cashed in his life insurance policy to purchase a new home. He had paid premiums of $12,000 and collected $50,000 from the insurance company.

Turquoise Company purchased a life insurance policy on the company's chief executive officer, Joe. After the company had paid $400,000 in premiums, Joe died and the company collected the $1.5 million face amount of the policy. The company also purchased group term life insurance on all its employees. Joe had included $16,000 in gross income for the group term life insurance premiums. Joe's widow, Rebecca, received the $100,000 proceeds from the group term life insurance policy.

Fresh Bakery often has unsold donuts at the end of the day. The bakery allows employees to take the leftovers home. The employees are not required to recognize gross income because the bakery does not incur any additional cost.

For a person who is in the 35% marginal tax bracket, $1,000 of tax-exempt income is equivalent to $1,350 of income that is subject to tax.

All employees of United Company are covered by a group hospitalization insurance plan, but the employees must pay the premiums ($8,000 for each employee). None of the employees has sufficient medical expenses to deduct the premiums. Instead of giving raises next year, United is considering paying the employee's hospitalization insurance premiums. If the change is made, the employee's after-tax and insurance pay will:

The de minimis fringe benefit:

When Betty was diagnosed as having a terminal illness, she sold her life insurance policy to Insurance Purchase, Inc., a company that is licensed to invest in these types of contracts. Betty sold the policy for $32,000 and Insurance Purchase, Inc., became the beneficiary. She had paid total premiums of $19,000. Betty died 8 months after the sale. Insurance Purchase, Inc., collected $50,000 on the policy. The company had paid additional premiums of $4,000 on the policy. Betty is not required to recognize a $13,000 gain from the sale of her life insurance policy and Insurance Purchase, Inc., is required to recognize a $14,000 gain from the insurance policy.

The earnings from a qualified state tuition program account are deferred from taxation until they are used for qualified higher education expenses. At that time, the amount taken from the fund must be included in the gross income of the person who contributed to the account.

Sam was unemployed for the first two months of 2017. During that time, he received $4,000 of state unemployment benefits. He worked for the next six months and earned $14,000. In September, he was injured on the job and collected $5,000 of workers' compensation benefits. Sam's Federal gross income from the above is $18,000 ($4,000 + $14,000).

If a tax-exempt bond will yield approximately .65 (1 - .35) times the yield on a taxable bond of equal risk, who benefits from the tax exemption: the Federal government, the state and local governments who issue the bonds, or the investors?

Jack received a court award in a civil libel and slander suit against National Gossip. He received $120,000 for damages to his professional reputation, $100,000 for damages to his personal reputation, and $50,000 in punitive damages. Jack must include in his gross income as a damage award:

Cash received by an employee from an employer:

During the current year, Khalid was in an automobile accident and suffered physical injuries. The accident was caused by Rashad's negligence. Khalid threatened to file a lawsuit against Amber Trucking Company, Rashad's employer, claiming $50,000 for pain and suffering, $90,000 for loss of income, and $70,000 in punitive damages. Amber's insurance company will not pay punitive damages; therefore, Amber has offered to settle the case for $100,000 for pain and suffering, $90,000 for loss of income, and nothing for punitive damages. Khalid is in the 35% marginal tax bracket. What is the after-tax difference to Khalid between Khalid's original claim and Amber's offer?

The taxpayer is a Ph.D. student in accounting at City University. The student is paid $1,500 per month for teaching two classes. The total amount received for the year is $13,500.

Mia participated in a qualified state tuition program for the benefit of her son Michael. She contributed $15,000. When Michael entered college, the balance in the fund satisfied the tuition charge of $20,000. When the funds were withdrawn to pay the college tuition for Michael, neither Mia nor Michael must include $5,000 ($20,000 - $15,000) in gross income.